Death and Taxes - Planning

When I was in high school, my best friend came from a background much different than my own. From a young age, he and his siblings worked. Not to generate a little extra spending cash like I did; they contributed to the family income out of necessity.

His mother, who was their head of household, had an interesting rule that stuck with me. When she or my friend or his brother came into a bonus or some overtime, not all of it automatically fueled the family coffers. Whoever’s windfall it was kept a portion of it to do with what they pleased. The rest went to common finances.

Now you might think this arrangement seems a little harsh. Shouldn’t the person who did the work get to say what happens to that money? Maybe. But his family lived more hand-to-mouth than I ever have, mostly due to circumstances of birth which I won’t get into. For them, middle class was a goal, not a birthright. Theirs were subsistence economics. This arrangement was a necessity to keep the family afloat.

But my friend’s mother was a very wise woman. I learned a great deal from her on a variety of subjects. Here, she was tapping a fundamental piece of economic psychology, one I’ve used to our advantage again and again.

Pay yourself first. But don’t starve yourself of a reward for your efforts or good fortune.

This is an important concept, one many people miss.

I’ve said before, personal finances are a lot like dieting. Making a radical change and going into starvation mode usually doesn’t work. In fact, most studies have found that mindset is counterproductive. Partly because we can only go so long before we need a reward or treat for our efforts. Yes, most of us are little children deep inside, or Pavlov’s pet. If we deny ourselves for too long, we are likely to binge when we get the chance to make up for what we missed. That’s deep-rooted evolutionary psychology from a time when our daily existence was often feast or famine.

I know better than fighting fundamental psychology. My id is devious and cunning. It almost always wins these fights. It will definitely fixate on what it’s missing. But if I can put it to sleep with a little treat, it will focus elsewhere.

Example time. As I said before, when Karen and I were living in Maryland, she was carrying some credit card debt. Anyone who thinks federal employees are overpaid has never tried living on one’s salary right out of school in DC. Anyway, to work it down, she needed to save some money. One of the ways she did this was by always paying herself first.

Back in the day, we didn’t use credit cards for daily expenses. Not only was it impractical, it was also actively discouraged by most businesses. For our day-to-day needs, we carried cash. Fortunately, greenbacks not the Rai stones.

Which meant every payday Karen went to the bank or ATM to withdraw money to see her through the week. To pay herself so she could work down her debt, every time she withdrew money from checking, she made an equal transfer from her checking to savings. This simple act reminded her that debt was still out there needing to be paid. At the end of each month, she took the extra she’d saved and applied it to her credit card debt, rather than just throwing in the minimum payment. In under a year, the debt was gone.

But she didn’t starve herself of a little spending cash to see her through each week. Which meant for her the practice was sustainable.

Once banks got a little more electronically sophisticated, this became easier. As I mentioned in the essay on budgets, we created a hierarchy of deposits which fuels our overall finances. Karen’s paycheck goes directly into our joint savings. From there, we have an automatic transfer to our joint checking for our normal monthly expenses. We also have two more automatic transfers to each of our personal savings accounts (where we each have another automatic transfer to our personal checking accounts). It’s a kind of waterfall effect, with money flowing in then dividing into separate pots, each without our having to intervene.

We operate out of our checking accounts. Which means we don’t see our savings on a day-to-day or week-to-week basis.

As I’ve said before, we don’t miss what we don’t see.

The money that goes into our personal accounts, savings and checking, is ours to spend alone. The other person doesn’t necessarily see where it goes, unlike the joint account. That means we each get to manage our own weekly reward and savings for special purchases without having to consult the other. Yes, we still buy special things for both of us out the joint account. But I don’t have to bother her with weekly lunches or coffee, or that special game I see in the local gaming store. She doesn’t bother me about yarn or jewelry. It works for us.

And because we use our checking accounts as our operating capital to meet our immediate needs, our savings (both personal and joint) continues to grow. Though part of this works because we grew up with checking accounts, not credit and debit cards.

We didn’t stop there. We used to have two more areas of automated savings, which through circumstances has winnowed down to one.

When I started my job down here in engineering, the company I worked for took their US Savings Bond drive very seriously. They prided themselves on 100% participation and got really tiffy if the CEO didn’t get honored for it by the government every year. They put a lot of pressure on employees to participate.

Being engineers, a number of individuals I knew just contributed the minimum allowed and set it so they would never receive a bond. A friend actually fought the unofficial policy by not contributing at all which ended with him in a series of managers offices receiving lectures all the way up to a VP.

I looked at it differently. I saw it as an opportunity. I contributed something like $25 a week to build up some savings. Savings bonds weren’t a horrible investment at the time (before George H. W. Bush gutted the way interest was paid). We continued contributing through Karen’s job until Treasury (under George II) restructured the program and made it much more difficult to contribute automatically. By then, we had enough bonds to put a new roof on the house. Those bonds, which continue to increase in value, serve as our house emergency fund. They aren’t a great return, but they are guaranteed. In general, they are better than a savings account and more accessible than a CD.

Our second automated savings opportunity is longer term. Both our employers had 401k plans or equivalent. Both had some level of matching contributions. This investment pays a couple different ways.

First, the contributions are pre-tax (tax deferred until you withdraw money in retirement which should be at a lower tax rate). So immediately, we are essentially saving our tax bracket on that money (when we started around 28%). That alone is an outstanding return on investment, though as I said, the taxes are just deferred.

But it doesn’t stop there. Because her employer matches her contributions in a hierarchy, they are basically giving her money to participate. Now here, a few people get confused. They think that because their company only matches the first, say, 3% they contribute from their salary one-for-one and the next 2% at one-half-to-one that they are only gaining 4%. In reality, they are gaining 80% on that investment (they contribute 5% of their overall salary to which the company adds another 4% of their overall salary for free). That is a huge return on investment even before taking into account the average gains on the S&P.

Of course, she can contribute more than that theoretical 5%. There is a maximum annual percentage as well as an overall hard dollar maximum. And because she’s over 50, there is an additional “catch-up” contribution which basically bumps that maximum up by another quarter. Since we’ve been married, we’ve maxed out our contributions, upping hers when she turned 50.

As well, Karen’s 401k equivalent has some of the best index funds and lowest management fees in the industry (much less than 1%). Which means almost all of her money goes directly to work. And because the contributions are automated each paycheck, we take advantage of any market dips throughout the year.

But wait, there’s more (order now and you’ll also receive…). Because, again, she doesn’t make that much money, we qualify to contribute another chunk of money (with another catch-up) to personal IRAs (traditional or Roth). And because she still doesn’t make that much money, the IRS subsidizes the first $4k of our contributions with a 10% tax credit ($400). For those keeping track at home, remember that $2k savings I mentioned in the essay on Discounts? Yup, there it is, working its little heart out so I don’t have to. And yup, that first year’s contributions are guaranteed the average S&P returns regardless of what the market does.

Now you begin to see where all that money we freed up from mortgage and car payments goes. Trust me, seeing the statements of how much we’ve saved provides a tidy little jolt of dopamine each quarter. And people are paying us to do it.

Let’s do a little quick math. Let’s say you have an employer that through a combination of direct contributions and matching is willing to add $4000 a year to your 401k. Let’s say you have a 30-year career ahead of you. And let’s say, because you are already pretty lucky, that you can capture the average S&P returns for that 30 years. What would you be leaving on the table by not taking it?

Plugging that into my quick search internet compound interest calculator (with annual payments)… $693090.64. Yup, you read that right, almost $700k. And that would be on top of the $866378.90 (just over $850k) from your $5000 a year contribution from the example above. That translates to $240k and $300k over a more realistic 20-year contributing career.

Ok, let’s settle back to something many people will find more realistic. Let’s run those same numbers for getting a $200 tax credit on $2000 IRA contribution, again for 30 years. The annual tax credit alone ends up worth just under $35k. The base $2000/year contribution ends up at just under $350k. (see the Notes and Asides for a caveat to these calculations)

Thirty years. For most people with a full retirement age of 67, that means starting those contributions at 37 years old. Quite doable.

Now of course, with inflation, management fees and the vagaries of the market, it’s not quite worth that much, but you get the idea. That’s a lot of money left on the table.

Pay yourself first, especially for retirement. What you don’t see, you won’t miss. And always take the free stuff. Win-win-win.

And there’s one more little tax break we take advantage of, Karen’s Flexible Savings Account, which basically allows us to spend pre-tax money each year on medical expenses (including dental checkups and glasses). While the rules are more Byzantine than an HSA, and the amount we can contribute is limited, we can’t beat the subsidy on routine medical we get from it being pre-tax. Beats the S&P any day.

Of course, before we were in that position, we were paying down debt. So, when Karen received a small inheritance, she used half of it to pay off the remaining note on her car. The other half she used to take us on a trip. When I was deep into overtime the year we got married, over half that money got poured into the mortgage, which is how we eliminated it even earlier. The other half went into things we wanted around the house. Now, if Karen gets overtime, a bonus or travel money (which doesn’t always happen and isn’t much), half gets dedicated to funding our IRAs and half usually goes to vacations (with at least some amount to yarn).

Which brings me back to allowances and another principle we live by: When it’s gone, it’s gone.

Funny thing about an allowance. In my experience, until very recently, I would always spend whatever money was in my pocket. When I had very little money, I didn’t spend it if I didn’t have it. When I increased my allowance, I usually spent close to the limit I carried. By the way, yes, I used to track this in my budget numbers, mostly out of curiosity.

Again, this is fundamental psychology for most of us. If you don’t have it, you won’t spend it. Of course, credit cards changed that calculus significantly. With them, it’s quite easy to spend what I don’t necessarily have, or at least want to have.

Remember way back in the essay on budgets where I said there were two kinds of budgets, a long-term and a short-term, and I said I’d get to the short-term later? Guess what time it is.

Full disclosure, I ran across this exercise in some article or book about twenty-five years ago. Credit cards had just begun to become ubiquitous for daily purchases, at least in certain crowds, which included me at the time. Because of the ease of purchases, more and more people were getting into trouble with them.

The exercise went like this. Set your credit card (or debit card) aside for a month. Each week, take out your allowance from the bank in cash. Yes, most people have what they consider to be an allowance, even if not a formally designated one. Instead of putting that cash in your wallet, stick it in a small notebook you carry in your pocket. Every time you spend any money, write it in that notebook with a date and time. It doesn’t matter how small the amount, even $1. Just make sure it’s noted every time.

At the end of the month, review those purchases. Group them into categories which can be broad or narrow, like lunches, dinners, coffee, movies, drinks, clothes, jewelry, craft or hobby supplies, gifts, gas, cigarettes, etc. Whatever categories best fit. How many of those purchases do you not remember making? How many that you remember gave you a distinct sense of joy? How many were just out of habit?

Many people end up being amazed how much they spend on coffee in a month. Or alcohol. Or cigarettes. Multiplying that by 12 gives you how much you spend on any given category in a year. The cliché example is buying coffee on your way to work each morning. It’s only $5. I hear that from people all the time. It’s only $5. That’s $25 a week, or $1250 a year. Even $5 a week is $250 a year. The question to then ask is do you get that level of enjoyment out of that purchase?

For me, this was a useful exercise. One of the things it changed was that instead of stopping in the company cafeteria for coffee each morning (which was crap), or buying into one of many coffee funds (which were also crap), I bought a thermos and started bringing in coffee I brewed at home (which was definitely not crap). A cheaper, better alternative. I also cut back going out to lunch to only Fridays, which had the added side benefit that I lost weight even though I wasn’t really trying to. All of which meant my allowance stretched farther and my savings built up faster (as well as my looking more svelte).

Now I’ve never really liked shopping but once upon a time in her princess days, Karen did. Every now and then she still gets the itch (she grew up as a mall child, just like me). She finds that sometimes grocery shopping can fulfill that urge. Other times, it’s thumbing through catalogs. If she’s really jonesing, she goes shopping for shoes or bras she really needs. That almost always cures her. It’s a weird trick but one that works for her and doesn’t burn through her allowance buying things she doesn’t necessarily want or need. In favor of things she does, like yarn.

When it’s gone, it’s gone.

That same philosophy applies to us with maintenance.

A number of years ago, we were watching an American Experience on the Great Depression. One of the sayings used by people who went through it or were born into it was, “Use It Up, Wear It Out, Make It Do or Do Without”. When I bounced that off my aunt, who was born in the middle of it, she said, that’s exactly right. So many people could learn from that in today’s disposable society.

For us, that translates to waste not, want not. As I’ve mentioned earlier, we will fix or improve things rather than immediately buying new. Which, oddly, seems to get reflected in the amount of trash we put out compared to our neighbor’s trash migration each week (they are always coming home with something). A personal choice.

But we have found that when we take care of things, we value them longer. And if we have fewer of them, we don’t get paralyzed by having too many choices, which is another condition confirmed by psychological studies. More on that in another essay.

In general, maintaining a car or the AC, though somewhat of a hassle, is easier than the bigger hassle of buying a new one. And as I’ve said before, we prefer to buy quality which we think will last. It probably helps that neither of us ever looks forward to shopping for new things because our tastes run far enough outside the norm that we can rarely find what we want or envision.

As I mentioned, my car is almost 30 years old. A bunch of years ago, a friend who we gamed with offered me double its Blue Book value. Cash. Tomorrow. He was dead serious. As was I when I turned him down. But to get an offer for half of what I’d paid for it a decade later said something about both the initial choice I’d made and the way I’d taken care of it. Our mechanic used to make us offers to sell it all the time. Of course, I’ve replaced the roof and Karen’s now resewn the seats.

We’ve bought one set of bedroom furniture since we’ve been married. It’s solid pine and matches a number of bookshelves, the spare bedroom set, end tables, a set of storage cubes, a corner cabinet, a chair, a sweater chest, a stereo cabinet, a wine rack and the game table. We picked it up in stages as we could afford from various manufacturers, some at closeout. Several years ago, when we had a mold issue in the house, we had to take all of it out into the garage and revarnish it. I’ve had to repair a notch taken out of one of the bookshelves. Just last month, Karen had to replace the cheap staples they used on her drawer fronts with screws.

But we knew when we bought it that it would last if we took care of it. Sure, there are scratches from various cats either using a piece as a launching board or making a hard landing. But those varnished over scars just remind us of those missing cats. And in the intervening years, Karen has made a paperback shelf, a DVD cabinet, two CD cabinets and a game table top to match the set. And all of it still glows when it catches sunlight.

As another example, when we first moved into the house, Karen really wanted a solid wood front door. We both wanted a door with a window but she insisted on solid wood. We made a deal. If she took care of it, we would get it. Which she has. Every year, she goes out, sands it and applies a fresh coat of spar varnish. This year, she made repairs to the jam where it had rotted from below. But looking at it, you wouldn’t think it was a 25-year-old door. We’ve known people who couldn’t get their solid wood doors past year five. Personally, I don’t think I could have. But Karen did.

A quick third example. When we bought the house, the back bathroom had countertops that could best be described as Flintstone fluorescent green marble. Yeah, lovely. Oddly, Karen (it was her primary bathroom) decided that she didn’t really want that color scheme. But instead of ripping out the cabinets and countertop and replacing them with something new, she had it resurfaced with a new laminate including replacement cabinet doors and drawer fronts for a fraction of the cost. And that minor improvement endures to this day as both of us remain content with the conservative color scheme she chose.

And in case you think it’s just her, ask me about the 25-year-old pair of Birkenstocks I glue back together every time the leather separates or the cork cracks. They cost a lot more than regular shoes, but no pair of sneakers has ever lasted that long. And I wear them every day around the house. Or ask about the only pair of dress shoes I’ve ever bought that still hold a polish.

Sometimes you have to spend money to save money. Our house is 40 years-old this year. Our cars are 30 and 17. Our washer (with a new knob) and dryer, almost 30. Our stereo and speakers (some of which we’ve refoamed), 25. Our freezer, almost 20. Our fridge and dishwasher, 15. Our TV (with a replaced power supply), 14. Our stove is original to the house. The list of items we could have upgraded or replaced for newer models with more features goes on and on. But what we have suits our needs and desires just fine. Quality shines.

I’ve found that there is something about pride of ownership that makes people envy what you have just as much as if you had the biggest, brightest, newest, ooooow shiny. And sweat-equity costs so much less than replacement if you start with good bones.

Simplicity, discipline, patience and planning.

Which brings me briefly to the first part of the title. Planning for the inevitable but unforeseen.

A number of years ago, I was talking to my mother when the subject of life insurance came up. I mentioned that while Karen has a basic amount provided through her job (with no premiums for us), we don’t have a policy on me. She was aghast. How could we not have life insurance? (kind of missing the point we did on Karen, just not on me. When I was in engineering, I carried a minimum policy, too).

Well, we don’t really need life insurance at this stage of our lives. The intent of life insurance is to provide a replacement income in case someone dies. It makes a lot of sense for young couples just starting out or couples with kids, or anyone with a dependent who might not be able to make up that income. A minimal amount makes sense to save someone burial costs (which we could get for free through our credit union). We are not in that position. If we had kids, it might be different.

Insurance at its heart is a hedge against uncertainty. In most cases the uncertainty is likely to occur, we just don’t know when. Everyone dies. The vast majority of us get sick. Many people get into auto accidents, whether through their fault or someone else’s. At its heart, the insurance industry, which has been around at least 2000 years, studies the average occurrence of various possibilities and their costs in various locations (ok, this is how it ideally works, so save the snark).

Because like most of people who don’t have the operating manual to their crystal balls, we don’t know whether certain events will occur (like a direct hit by a hurricane, or breast cancer) or when (like dying). In general, insurance provides a good hedge against that uncertainty, in much the same way a fixed interest rate, fixed payment mortgage hedges against interest rate uncertainty. With insurance, pooling the risk among a large enough population is what allows those collected statistics to work.

In general, I like hedges against uncertainty. If I had any lingering doubts, 2007 cured me of them. But likely I would have been content either way because I understand the math and how the dice can roll.

In the same way, while I would never willingly go without health insurance (having it in 2007 paid us to the tune of $300k in dividends), we don’t need dental insurance right now (it’s a wash because our teeth are sound). We might be able to get our money out of vision insurance but every time I’ve run the numbers, it’s been basically a wash with the other discounts we can unlock (which don’t stack).

Homeowners insurance we still have even though we no longer have a mortgage (which requires it). Though with the rise in premiums and deductibles for wind-storm damage, it might be better to get an umbrella liability policy combined with another for fire, theft and casualty. I’m not quite ready to make that leap.

Auto insurance is required by law, and I am generally lawful at heart. Though with the age of our vehicles, comprehensive really doesn’t do us much good (except for replacement windshields for the Jeep, which has needed two). And because we have good health insurance, we don’t really need the coverage for uninsured motorists as I understand it.

We’ve considered long-term care insurance through Karen’s work but unfortunately, the opportunity to sign up for it only comes around every 5-10 years. The last time it did, she was still disqualified for being too close to her final treatment. Regardless, I have heard mixed reviews on whether you can ever get your money out of your premiums. It is increasingly difficult.

All of these are planning trade-offs with potential savings and expenditures that we weigh out year after year as our situation changes. But like an old Soviet 5-year forecast, life often has other plans.

Which is why we keep living below our means. As we plan to do for the foreseeable future. 

© 2019 Edward P. Morgan III 

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